Wednesday, April 27, 2011

Bernanke Talking to the Press

In case you had not heard, Ben Bernanke will be giving a press conference this afternoon following the FOMC meeting. This is a unique event in Fed history, and a bad idea, as this NYT piece should make clear to you.

Bernanke's authority comes from Congress, and he is required to report to it and answer questions twice per year. On these occasions, he gives a statement, like this one, and then he is grilled for a few hours in a committee hearing. The Fed issues policy statements after every FOMC meeting stating the current settings for policy instruments and the likely future course of policy. Bernanke also gives speeches, explaining what the Fed is up to. All of this is fine. The Fed needs to be held accountable, and there should be political oversight of its actions, and periodic review of the legal structure within which it operates.

Venturing into the political arena, though, has no upside. The Fed's independence is valuable, particularly when the going gets tough and Congress has an incentive to focus on short run problems at the expense of long-run stability. Sometimes it is best for the Fed to lie low and hope no one notices what it is up to. Bernanke's key flaw comes from his experience as a teacher. He thinks things can be made right by simply explaining himself carefully. Everyone will understand. Then it will be OK.

As the New York Times piece makes clear, there are plenty of people out there who believe that there is something the Fed can do under the current circumstances which will lower the unemployment rate. Believe me, the Fed has done essentially everything in its power to do so. Whether there are sticky prices, sticky wages, credit market frictions, or whatever at work in the economy (or not), there is absolutely no action the Fed can take now that will lower the unemployment rate (in part for reasons discussed here). For example, by committing to an extended extended period where the interest rate on reserves sits at 0.25% (say three or four years), the Fed just risks a serious inflationary period, and gives us no benefits at all.

Bernanke (as the NYT piece tells us) has in fact led people to believe that the Fed has the tools in its box to lower unemployment under current conditions. Given this is not true, going out in public and defending that view cannot lead us anywhere where we want to go.

Yes, there is no news in the press release. As expected, there is not change in the asset purchase program, and no change in the "extended period" language. You could certainly argue that, so far, QE2 has not done any harm.

I must respectfully disagree with your claims that (1) the Fed has done all it can do and (2) there is nothing more it can do. The Fed has failed to set an explicit level target--whether it be a price level or NGDP level target--that would allow much more aggressive monetary easing while still maintaining long-term price stability. As noted here, QE was incredibly effective during the the Great Depression when the economy was in far worse condition than today.

Bernanke made this point himself many times for Japan in the 1990s as an academic, but now has somehow forgotten his own work. QE2 is a weak attempt by the Fed that could have been so much more.

I will concede this point: if you mean the Fed could not have done more due to political constraints, then yes. But the latent power of the monetary policy is there.

Relative to all of the other acts of communication the Fed engages in, it's not obvious that this press conference, on the margin, is such a fundamental shift. Is there only downside risk? Perhaps.

David Leonhardt, the author of the NYT piece referred to, recently won a Pulitzer Prize in the 'Commentary' category 'for his graceful penetration of America’s complicated economic questions.' The sophomoric tone of the article, e.g., multiple references to the claim that Ben Bernanke 'decided to accept widespread unemployment for years on end,' suggests there wasn't much substantive competition in the Pulitzer Prize 'Commentary' category this year.

What about the announcement that the size of the balance sheet will be maintained? Prior to today, I wasn't sure if they were going to rollover maturing securities or cancel the liabilities and let the balance sheet shrink. That's probably $5 or so billion in purchases a week, post QE2.

the Fed has not done this historically. See below. Then please explain why you think they will do it in the future, particularly if they take your approach, which would likely lead to even higher risk of higher rates of inflation.

"The Fed has failed to set an explicit level target--whether it be a price level or NGDP level target..."

Yes, there could be something to that, as it says something about policy in the future, in spite of the fact that there is actually no action (i.e. an asset swap or a change in the interest rate on reserves) the Fed can take today that would make a difference. However, the Fed has been fairly explicit about the 2% inflation rate target. Bernanke even stated the number.

I had not realized Leonhardt got a Pullitzer. Go figure. Ultimately what I saw of the press conference was pretty dull. I guess we have to live with this forever now. Bernanke's successor will have to do it as well, or look too secretive and withholding.

"If keeping the target rate low for years risks inflation, then inflation expectations rise, real interest rates fall, and the policy is effective."

You realize that doesn't work, don't you? If you try to maintain the low nominal rate under those circumstances, the inflation rate keeps increasing, this becomes very disruptive, and as a central bank you are seen as doing a very bad job.

"What about the announcement that the size of the balance sheet will be maintained?"

Yes, it depends on what you were expecting. I was thinking of that piece of policy as set before the QE2 program, and not part of it. Thus, as planned, QE2 ends, but the Fed keeps replacing the MBS and agency securities with Treasuries as they run off. This is indeed an active policy, though of course it fixes the size of the balance sheet in nominal terms. In real terms, the size of the balance sheet will fall, but at a low rate.

When the Fed says price stability, they really mean: "Our goal is to achieve 2% inflation per year, more or less." Why 2% and not 0%, 1%, or 5%? They really don't have a good reason, other than that we have been close to that (a little above, by your measures) and that seems to be OK, in that it seems hard to find any significant negative impact from 2% or 3% inflation over an extended period of time, in the US or in other countries.

"A lot depends on how much you know. Are you an undergraduate student? A graduate student? Neither? How much economics/math/computation do you know?".

An undergraduate just graduated from collegue, with some knowledge on math (Chiang´s level or so), who has worked out your awesome Macro text from the beginning to the end, and with no clue on MATLAB and similar programs, but highly motivated to try to remedy that lack.

Matlab is fairly easy to use, if you understand a bit about programming languages. I don't know much about the McCandless book. The table of contents made it look like it was relatively heavy on 1980s quantitative methods, so it may not be as up-to-date as it could be. He has an earlier book with Wallace that was OK. I am not a huge fan of Carl Walsh's book, but it has been around for quite a while, and the benefit would be that it would provide a relatively easy entry into quantitative methods, and otherwise give you some pretty basic theory. A book that is widely used in PhD macro courses is this one:

Yes, that gets it about right. It was quite dull, and revealing essentially nothing. A typical central banker performance. Not clear that this makes anyone feel better or worse about the Fed, so why do it?

Stephen Williamson, please explain why recommend Recursive Macroeconomic theory to someone who says he wants an introduction to RBC with his matlab and math level? I would have guessed that it was to advanced.

I have only a bachelor in economics so I'm not going to argue with you. When we used Romer we also used your lecturenotes in macroeconomic theory and I want to say thanks. Why not recommend them?

"it seems hard to find any significant negative impact from 2% or 3% inflation over an extended period of time"

Perhaps. But there are clearly other drawbacks to inappropriate policy, such as creating moral hazard and creating or contributing to asset price bubbles. These have costs, even if they're hard to quantify, and it seems reasonable those costs might be significant.

Sure, you could use my lecture notes. I did not want to extend a blanket recommendation there, as only parts are up to date, and if you wanted to learn anything about computation or estimation it's not in there. If I had the time I would write it properly, but time is scarce.

"But there are clearly other drawbacks to inappropriate policy, such as creating moral hazard and creating or contributing to asset price bubbles."

Moral hazard: Actually, contrary to what you hear sometimes, the moral hazard problem actually kicks in at high interest rates, not low ones.

Bubbles: Not clear at all what anyone actually means when they say "bubble," so how would you know when you actually see one? I have a particular notion of what a bubble is, and it could actually be a good thing.

The simplest example is a monetary bubble. Fiat money is intrinsically useless. It does not confer on the owner any explicit payoffs, so its fundamental value is zero. Yet, people accept it in exchange for goods and services under the self-fulfilling belief that other people will do the same in the future. There is then a liquidity premium on money, captured by the difference between the value money has in terms of goods and services, and its fundamental value (zero). There's a bubble, and the existence of the bubble makes us better off, as otherwise exchange would be much more difficult. The same thing applies to other assets which are used in exchange - asset-backed securities for example.